Pando

Wall Street predicts huge IPO bounce in September… was that it for the great unicorn crash of 2016?

By Sarah Lacy , written on August 12, 2016

From The Venture Capital Desk

Since at least the third quarter of last year, industry watchers have been looking for new ways to say “this can’t last” about the venture capital market.

More companies founded in a few years with a $1 billion-plus valuation than exited for $1 billion or more over the last decade.

The continuation of mega-rounds at sizes and prices never before seen in the industry.

All while the industry’s returns suffer.

We had one of the worst starts to the IPO markets in recent memories, and acquisitions haven’t been much better. Today, Calpers noted that venture capital is its worst performing private asset class. The country’s largest public pension fund said that returns from VCs were just 7% over the last five years and just 5.6% over the last decade.

Flummoxed at what can only be accurately described as a steady but modest deceleration of deals done while the amount invested continues to rage, researchers have simply thrown up their hands. “We continue to see things we’ve never seen before,” said PriceWaterhouse Cooper’s Tom Ciccolella in the press release for the second quarter Money Tree report.

This week, some encouraging news came from JP Morgan’s Liz Myers, the global head of equity markets. She told Bloomberg the bank has more than 20 IPOs lined up for September. She added: “I’m optimistic that we’ll see that trajectory persist through the fall and into year-end.”

Also from the piece:

Companies planning to go public have been encouraged by recent deals. Some two-thirds of IPOs in 2016 have been priced at or above their marketed range, according to Myers. They’re also doing well once trading starts: The average share performance from the offer to date is more than 20 percent, she said.

What’s more she listed tech companies as the most likely candidates.

The Wall Street Journal adds to the speculation fire that Uber-- the granddaddy IPO in terms of price and anticipation-- could be one of them. From that piece:

Here’s another factor: the likelihood that Uber’s revenue growth will soon slow significantly, if it hasn’t already.

Since Uber’s shareholders aim to fetch the highest possible price for the company, it is better for Uber, which remains unprofitable, to go public before its growth slows too much. If Uber times it right, it can make investors in public markets believe it is a good buy—even at a valuation greater than its most recent $68 billion 

On the question of Uber, I’ve argued the same logic. Uber risks waiting too late to go public and missing the natural peak of its life cycle, something I’ve argued may have happened to Pinterest already. It’s doubly bad for Uber because it operates a commodity product, it’s growth avenues like international and general logistics and delivery haven’t gone well, and it’s facing Google/Tesla/Apple in the self driving car era-- all companies that have deeper pockets, hardware and brand advantages over Uber.

Uber’s main advantage has always been cash. It didn’t have that in China and lost. Imagine the self driving car era with it competing against three companies that have a combined market cap of more than $1 trillion. Kinda puts that runaway $68 billion valuation of Uber in perspective.  

But Uber is not a company that conforms to logic. It’s just as likely they ditched the money-losing China unit in order to stay private longer without raising more billions, as it is that they ditched it to prepare for an IPO. If Uber is smart they IPO. Uber is smart. But Uber is also stubborn, and CEO Travis Kalanick has long said he wanted to put it off as long as possible. There is nothing forcing them to go now.

JP Morgan’s Myers, for one, said she doesn’t expect the biggest tech companies to file until 2017 or 2018, despite her bullishness on a market recovery. Airbnb, too, is in the midst of raising another mega round, so count that one out. And I’d be stunned if Snapchat filed this year.

But the mega-decacorns aside, a general breaking of the IPO log jam-- encouraged by the success of Twilio and others-- or even an acceleration of $1 billion deals emboldened by Jet and Dollar Shave Club would be a meaningful sigh of relief for VCs. That it could come next month is quite the turnaround from a bleak year of returns.

If true, if those IPOs performed well, I have to wonder, would that be the end of the expectation of a “crash”? Would the great anticipated unicorn carnage simply not have occurred?

And if so, what then?

Many VCs argue that part of the reason that burn rates had gotten so out of control was that this generation of entrepreneurs have never worked in an environment where raising money was hard. And after 18 months of concern trolling that a crash was coming, entrepreneurs will still not experience a time when funding was hard to come by.

That isn’t good. Nearly anyone who has built or invested in a hugely successful company will tell you that too much money is a good problem to have. Nonetheless, it creates a lack of discipline and other bad habits within companies. At a macro level no correction, after a period with this much excess, is not a good thing.

For one thing, although there has been some easing in the commercial real estate market, LINK salaries are still sky high. The longer there’s no correction, the more overstretched talent is and the more expensive it is.

And that in turn exacerbates the Bay Area’s housing crisis. We all hear about how bad housing is in San Francisco (and, to be clear, it is) but segments of the peninsula are actually worse. You need a gross income of more than $700,000 to live in a small, old single family home in Palo Alto proper right now. Just this week, Kate Vershov Downing  resigned from the planning and transportation commission in Palo Alto, because she could not afford to live in Palo Alto. Someone on the zoning commission was zoned out!

Sorry teachers, sorry artists, sorry folks who work at nonprofits, sorry everyone else not tech, and frankly sorry a lot of folks who do work at startups but in non-executive jobs: Dozens of IPOs will make this far, far worse.

There’s a concern for employees too. Even if unicorns are able to get out into the public markets, there may not be a lot of room for appreciation. Let’s look at the last wave of the consumer Internet: There was one gargantuan win in Facebook that’s basically carving up the digital ad world along with Google. And then there was the very wounded Twitter, the sold off LinkedIn, and a lot of companies in the $1 billion-$3 billion range. In a normal era, even those are great successes. They aren’t when your company is already worth billions in the private market.

Doesn’t matter for early stage investors who will make money no matter what, but depending on when employees joined a company they might not have much to celebrate. And stagnant valuation growth always weighs heavily on the morale of a company.

And then there’s one last concern. In the great dot com bubble of the late 1990s, one thing that made it so devastating on a broader economic scale was that VCs largely made money, and they shoved the unsustainable companies onto mom and pop investors via premature IPOs.

Now, no one is suggesting there’s a rash of premature IPOs these days. Likewise, I’m not arguing that these companies don’t have real revenues and huge potential markets.

But one of the big differences I’ve argued for more than ten years about a concern that tech companies are overvalued is that this time around, it’s only insiders who would be punished. If there’s no market correction and these stocks go public, that could change.

But let’s walk before we run. This hypothetical is all based on the idea that what JP Morgan reports in a Bloomberg interview about September is reflective of other banks and the markets through the end of the year.

All we know so far is this: There’s so far been no meaningful correction in a private equity market where new firsts are continually occurring each quarter, and the only reason to hope a correction occurs is a year of lousy exits.